by Shawn Narancich, CFA
Executive Vice President
Equity Research and Portfolio Management
New Year’s Resolutions
After being caught flat-footed by inflation last year, the Federal Reserve maintains a steely resolve to ensure that the beginnings of slowing inflation witnessed last fall continue in 2023. Following the stock market’s worst year since 2008 and the worst year ever for bonds, investors are hoping for better days in 2023. Inflation is beginning to moderate amid considerably higher short-term interest rates from the Fed and the attendant weakening of demand in cyclical sectors like housing. Relatedly, the money supply verges on negative year-over-year readings for the first time in a generation. As the renowned economist and Nobel laureate Milton Friedman once observed, “inflation is always and everywhere a monetary phenomenon” of too many dollars chasing too few goods. Per his observation and the chart below, the leading nature of money supply supports our thesis that inflation will come off the boil in 2023, assuaging the Fed and allowing for a less aggressive approach to rate hikes this year.
Source: Bloomberg
Reading the Tea Leaves
Because wages and salaries account for such a large portion of company costs and related pricing, this week’s payroll report and incremental labor market data provide key signposts for the Fed ahead of its next monetary policy meeting on February 1. Job gains slowed again in December, with 223,000 new jobs created, but with labor market participation rates still muted, slower job gains were enough to push the unemployment rate down a tick from November levels. At 3.5%, unemployment is at a 50-year low and has actually declined slightly in recent months. The jobs number exceeded estimates, and the unemployment rate undershot expectations, both of which will be viewed negatively by a Fed working to cool the job market. On the other hand, policymakers will note that wage gains continued to cool in December to a 4.6% year-over-year rate. Finally, the Job Openings and Labor Turnover Survey (JOLTS) reported this week revealed that job openings actually rose in November.
Combined with a generationally low unemployment rate, the Fed will view 10.5 million unfilled jobs vs. approximately six million unemployed Americans as a key signal that the labor market remains too tight. Amid layoff announcements by the likes of Amazon, we expect the Fed will hew to market expectations and slow its pace of rate hikes to just one-quarter of a percentage point next month.
The Bigger Picture
More broadly, investors anticipate that the Fed will increase short-term rates to the 5% level later this year before halting this cycle’s rate hikes altogether. We agree that the end is in sight for Fed rate hikes and that if a slowing economy morphs into something worse, a recession this year will be short and shallow. In a slowing economy, we are more concerned about cost pressures in a tight labor market, dampening corporate profit margins and causing earnings to dip in 2023. Accordingly, our stock picking has become more defensive.
Next week, the December inflation report will be spotlighted and should provide investors and the Fed with further evidence of slowing price gains. The fourth quarter earnings season also kicks off with money center banks like J.P. Morgan and Citigroup reporting.
Takeaways for the Week:
Labor market data provided both hawkish and dovish inputs to monetary policymaking
Stocks and bonds rallied on the payroll data, with the S&P 500 up 1.4% for the week and yields on the 10-year U.S. Treasury benchmark dropping by a quarter percentage point